The key drivers for M&A activity in Brazil are changing and will likely follow this new pattern for some time. After a long period of optimism within the country and its growing consumer market, as well as its commodities-based export portfolio during the commodity super-cycle, M&A transactions are now more related to the aftermath of the ongoing economic, political and fiscal crisis.

The M&A scene in the last couple of years can be described as being a buyer’s market. Many sale transactions have been involving distressed assets, large-scale debt restructuring and reorganisation procedures, divestment programmes of private and mixed-capital companies and sudden liquidity concerns.

In addition to the general credit crunch and economic downturn affecting many companies in Brazil, the reputation of large Brazilian corporations have also been hit hard by the so-called ‘Operação Lava Jato’ (or Car Wash Investigation), which has mostly affected oil & gas suppliers and construction companies. Another federal investigation (the so-called ‘Zelotes’ Investigation), related to bribes allegedly given in return for favourable decisions in administrative tax appeals, is expected to affect other sectors of the Brazilian economy.

The usual flow of an M&A transaction consists of due diligence, contract negotiation and closing after the conditions are met, including obtaining governmental approvals and third party consents.

Due diligence processes are mostly based on information provided by the seller, and may also involve limited independent investigative work by the buyer. Accordingly, the buyer seeks protection in the negotiation of appropriate representations and warranties, conditions precedent for closing, restrictions on the conduct of the target company between signing and closing and, last but not least, indemnities from the seller in the event of any breach. Specific issues may also be subject to special price adjustments and earn out arrangements.

Although the exercise remains basically the same, the major drivers of each step have changed. Increasingly, buyers have become more concerned with the seller itself, rather than only the target company. Although labour, social security, tax and environmental matters continue to be major aspects in such due diligence and negotiation exercises, compliance and integrity of the target company and other seller group companies, as well as seller’s capacity to recover from the economic or reputational crisis affecting it, have become key issues.

The typical concern in M&A transactions relies on the capacity of the seller to indemnify the buyer if something proves to be wrong (in case of breach of a representation & warranties, for instance). However, the continuing existence and solvency of the seller a few years later, as well as its size after all divestments and possible penalties imposed by authorities, became important and sometimes unpredictable questions.

Contractual provisions which might otherwise seem like market practice, allowing the winding up of the transaction or more strict conditions for closing, are strongly resisted by sellers in the current environment.

Sale and purchase transactions in the context of debt restructuring may offer certain protections against customary succession risks, provided that the applicable requirements are met. On the other hand, indemnities for other matters may not be on the table for a variety of reasons, including the multiplicity of stakeholders. Such transactions may require negotiation with, and acceptance of the deal by, the seller, its creditors, courts and the judicial administrator, just to name a few. Depending on the relevant industry, the regulatory agency or granting authority may also play an important role as changes of control are usually subject to approval and compliance with financial, technical and legal qualifications by the buyer.

Divestment plans, on the other hand, involve several assets of a company. This means that, after implementation of the divestment plan, the seller will have shrunk and the sale proceedings may have been fully used to repay short-term debt or to implement other projects, which would only generate cash a few years later, or not at all.

In addition, it is not unusual for large economic groups to have a high level of interdependence among their subsidiaries in different sectors, either through intercompany commercial arrangements or sharing of personnel, infrastructure or facilities. It is not an easy task to have such tight links broken as well as the seller’s corporate culture changed.

So, what is left in terms of protections for the buyer? The due diligence should be even more thorough and detailed than usual, with a special focus on compliance matters, not only with respect to the target company, but also the seller, its corporate group and other companies involved in the business. Security or collateral arrangements should also play an important role, considering the difficulty and cost associated with obtaining bank guarantees or M&A insurance in the current market.

In spite of all those challenges, foreign investors that have the financial capacity and a medium- to long-term view may have a rare opportunity to enter or consolidate their position in the Brazilian market. In addition to favourable foreign exchange rates, entry barriers are being lifted as large groups reduce their market share in sectors related to infrastructure, including oil and gas, road concessions and electric power.

The fiscal crisis affecting the federal government and most states in Brazil is also expected to open a season of privatisations, concessions and public-private partnerships at all government levels, and a reduced participation of the government in the economy. The last time a similar season opened in Brazil was in the 1990s.

In a worldwide economy, Brazil is often seen as the country of the future. Some rushed to say that the future had arrived a few years ago, but the recent bumps on the road confirmed that the future still lies ahead – as do opportunities for investing in a large country, with a diversified economy and a population of more than 200 million people, where the rule of law and institutions are being tested on a daily basis.

Marcello Portes da Silveira Lobo is a partner at Pinheiro Neto Advogados. He can be contacted on +55 21 2506 1609 or by email: mlobo@pn.com.br.